A Call for Japan to Take Bolder Monetary Action

For years, proponents of aggressive monetary policy have offered this unusual piece of advice as a way to end Japan’s deflationary slump and invigorate the economy. Print lots of money, they said. Keep interest rates at zero. Convince the market that Japan will allow inflation for a while.

Japan’s central bankers long scoffed at such recklessness, which they feared would ignite runaway inflation. But now, the bank’s hand could be forced by an unlikely alliance of economists and lawmakers who have argued for Japan to take more monetary action after more than a decade of weak growth and depressed prices.

Championing their cause is the former prime minister Shinzo Abe, who is favored to return to the top job after nationwide elections next month. Otherwise deeply conservative, Mr. Abe surprised even his own supporters by calling for the Bank of Japan to be much bolder in tackling deflation, the damaging fall in prices, profits and wages that has choked Japan’s economy for 15 years.

In escalating remarks over the last week, Mr. Abe has said that he will press the Bank of Japan to act on government orders if his Liberal Democratic Party wins the Dec. 16 election and even rewrite Japanese law to reduce the bank’s independence.

In a speech in Tokyo on Thursday, Mr. Abe said he would call for the Bank of Japan to set an inflation target of 2 to 3 percent, far above its current goal of about 1 percent, with an explicit commitment to “unlimited monetary easing” — an open-endedness that has caused jitters among some economists. The bank’s benchmark interest rate should be brought back to zero percent from 0.1 percent, Mr. Abe added.

He went even further over the weekend, saying in the southern city of Kumamoto that he would consider having the bank buy construction bonds directly from the government to finance public works and force money into the economy, according to local news reports. That raises concerns, however, the bank may be called on to bankroll unrestrained spending on more roads and bridges that Japan does not need.

Still, Mr. Abe’s comments initially galvanized markets, sending the Nikkei soaring by almost 500 points since Thursday, falling back slightly Tuesday. The yen, which would weaken if Japan loosened monetary policy, has fallen 2.5 percent, much to the relief of Japanese exporters who benefit from a weak currency.

“It’s been long coming, but we finally have hope for change,” said Kikuo Iwata, a professor in monetary economics at Gakushuin University in Tokyo and a longtime advocate of more aggressive easing. “If Mr. Abe becomes prime minister, he will not let the Bank of Japan play defense any longer.”

The strong reaction to mere comments from a candidate — before any fresh easing has actually taken place — demonstrates one of the less understood aspects of monetary policy: that expectations can matter more than policy. The Bank of Japan, which wrapped up a policy meeting on Tuesday, held policy steady.

The bank has in fact tried a series of measures to reinflate Japan’s economy over the years, including zero interest rates, asset purchases and quantitative easing. But prices have fallen for so long in Japan — since 1998, in fact — that Japanese have come to expect deflation. Try as it might, the Bank of Japan has been unable to change that expectation.

Economists cite several missteps by the central bank that have entrenched Japan’s deflationary mind-set and made consumers and businesses wary that the bank’s policies will stick. In early 1999, as the country’s economic woes deepened, the bank lowered a benchmark interest rate to virtually zero and said it would keep rates at zero until deflationary concerns disappeared. But an economic uptick in mid-2000 caused the bank to raise that rate to 0.25 percent despite protests from the government that the move was premature.

Behind that quick reversal is what critics call Japan’s severe phobia to any sign of an economic bubble. Japan has never recovered from its bubble economy of the 1980s, when stock and land prices quadrupled, only to tumble to almost prebubble levels as the country sunk into economic stagnation in the 1990s.

Photo

Shinzo Abe, Japan’s ex-prime minister and head of the Liberal Democratic Party, is expected to return to the top job next month.Credit
Toru Hanai/Reuters

Since then, critics say, the central bank has been so terrified of any sign of rising prices that it has held off from going all-out to fend off deflation, which has ultimately prolonged Japan’s economic malaise. Even after the central bank returned to a zero interest rate in 2001 and introduced quantitative easing, it was careful to publicize concerns about inflation and warn that it would tighten monetary policy as soon as prices began to rise.

The bank’s nervous easing ultimately did little to raise inflationary expectations. Japanese consumers continued to expect wages to fall and cut down on spending. Japanese companies, which expected profits to fall, held back from investing. Even as the central bank pumped banks full of money, bank lending hardly rose, and spending and investing remained depressed. Japan remained mired in deflation.

“If the central bank doubted its own policies, how could it ask anyone else to believe in them?” said Yutaka Harada, a professor of economic policy at Waseda University in Tokyo. “It needed to convince people that it was serious, that it would allow a little inflation to happen. It failed.”

Another reason the central bank has been reluctant to expand monetary policy, and to maintain its autonomy from the government, is that it does not want to be seen as a printing press that finances government spending.

If investors see the central bank as a source of easy money for the government, they could lose confidence in the government’s ability to rein in its mushrooming public debt, the bank says. A loss of confidence could increase the government’s borrowing costs, leading to a debt crisis similar to the one in Europe, it says.

“If there is a misunderstanding that our monetary policy is in fact a measure to finance government deficits, long-term interest rates could rise, hurting the real economy,” Masaaki Shirakawa, the Bank of Japan’s governor, said Tuesday.

Other critics challenge the view that monetary policy can get Japan’s economy moving. Instead, they point to deeper structural problems that they say must be addressed, like a rapidly aging population, prohibitive regulation or the hollowing out of the manufacturing sector.

Japan’s monetary pump-priming is “like a morphine addiction that is getting worse,” Ryutaro Kono, chief economist for Japan at BNP Paribas, said Tuesday. “Fiscal or monetary policy doesn’t have the power to create new value” for Japan, he said.

Proponents of a more aggressive monetary policy, including Mr. Abe, argue that beating deflation and getting the economy back on track is a better way to win investor confidence in Japan.

Committing to a little inflation will push stock prices higher, while a weaker yen will bolster Japan’s exporters and strengthen corporate balance sheets. Incomes will rise, fueling consumption and raising tax revenue for the government, said Kozo Yamamoto, a lawmaker of Mr. Abe’s Liberal Democratic Party.

“Basically, it’s what the Bank of Japan should have been doing for the past 15 years,” he said. “A few percent of inflation is nothing to be worried about.”

Even proponents warn that if Mr. Abe drums up expectations for a bold monetary turn, but fails to deliver, he could deal a heavy blow to investors, consumers and businesses.

“They will say, ‘I knew it. I knew it wouldn’t work,’ and become even more strongly resigned to deflation,” said Mr. Iwata. “That would be a disaster.”

A version of this article appears in print on November 21, 2012, on page B3 of the New York edition with the headline: A Call for Japan to Take Bolder Monetary Action. Order Reprints|Today's Paper|Subscribe